MAILBAG

No tax deduction for loan not secured by the home

Robert Bruss

Published: Saturday, May 5, 2007 at 6:30 a.m.

Last Modified: Friday, May 4, 2007 at 10:54 a.m.

Q: Last year, my wife and I loaned our daughter and son-in-law the money they needed to buy their first home. We weren't earning much on the money and they offered to pay us 5 percent interest. It was a good deal for them and a good deal for us. They faithfully pay us the monthly interest and principal. However, when they had their income taxes prepared, their tax adviser told them that the approximately $32,000 of interest they paid us in 2005 is not tax-deductible because it is an unsecured loan, which is not recorded against their title. Please tell us this isn't true. - Gregg G.A: Their tax adviser is correct. For your daughter and son-in-law to deduct the interest payments paid to you as itemized home mortgage interest, the loan obligation must be secured by a recorded mortgage or deed of trust against their home.
Although you and your wife must report on your tax returns the interest income received, the borrowers are not entitled to deduct it as home mortgage interest because the loan isn't secured by their residence. However, this can be corrected for 2006 by their signing and recording a mortgage or deed of trust to secure the promissory note they gave to you.Q: About a year ago, my husband and I refinanced our $375,000 home mortgage with a 5.5 percent interest rate loan. Now we are in a financial position to pay off our mortgage in full. But our CPA son-in-law advises against doing so. He says we need every tax deduction we can get. However, I would like to be free of the monthly mortgage payments. What do you advise? - Amy T.A: Listen to your smart son-in-law. Unless you are in a very low income tax bracket, your after-tax mortgage interest rate is only about 3.5 percent. That's a true bargain.
Surely you can find a safe place to invest that $375,000 to earn more than 3.5 percent interest. Then you will have that money available for an emergency or investment opportunity.
Another consideration is to check if your mortgage has a prepayment penalty. If it does, that settles the matter in favor of not paying off your mortgage.Q: About five years ago, my aunt died. She left everything to me, including a worthless lot. I consulted several nearby Realtors and they wouldn't even list it for sale as it is only worth around $5,000. However, the county keeps sending me the property tax bills, which I haven't paid. They have tried to sell the property at a tax sale but nobody will buy it even for the amount of unpaid property taxes. Now the county reported to the credit bureaus that I owe the unpaid taxes and this is hurting my credit rating. What can I do? - Ralph R.A: It is very unfair for counties to report unpaid property taxes to the credit bureaus, especially when you inherited worthless property you don't want.
Perhaps you can contact the county tax collector to see if he will accept your quitclaim deed in return for canceling the property taxes. Then you can tell the credit bureaus the property taxes have been canceled so the adverse information can be removed from your credit reports.Q: In 1993, my wife's father died. He left everything to her in his will. There are no siblings or other close relatives. Knowing she inherited the house, we moved our family in and have been living in the house and paying its mortgage ever since. Now that our kids are grown and on their own, we want to sell the house and "downsize" for our retirement years ahead. However, when we talked with a Realtor about listing the house for sale, she said we can't sell it until my father-in-law's estate is probated and the house title is transferred to my wife. Is there any way to avoid probate? - Jerome W.A: No. However, many states have speedy small estate probate procedures for situations like the one you describe. Because your late father-in-law willed his house, probate court proceedings are usually required.
Probate could have been completely avoided if he held title in his revocable living trust, specifying that after his death the house should go to your wife. However, it's now too late for that.
I suggest that your wife consult a local experienced probate attorney to probate the will. He or she can often expedite uncontested probate matters in less than the six to 12 months usually required.
But your wife has another problem to consider. When she receives the title, she will receive a new stepped-up basis to market value in 1993. Since then, the house has probably greatly appreciated in market value.
However, you and she can't qualify for the Internal Revenue Code 121 principal residence sale tax exemption up to $500,000 because she hasn't owned the house at least 24 months (although you both clearly meet the 24-month occupancy test). Consultation with your tax adviser is strongly suggested.
Send questions to Robert Bruss, 251 Park Road, Burlingame, CA 94010 or through his Web site, www.BobBruss.com Q: I live in a condo complex where one owner has four barking dogs. The neighbor has never walked the dogs and keeps them in a tiny fenced patio. The smell is unbearable in hot weather. The condo homeowner's association refuses to act even though the CC&Rs (covenants, conditions and restrictions) only allow one small pet. What can be done? - Dorothy J.A: Shame on your ineffective homeowner association board of directors and officers for refusing to enforce the CC&Rs. However, your city or county health department, or the local humane society, can take action to abate this nuisance, which is also a health problem. A few phone calls should solve the problem.Q: My friend and I have a disagreement about Internal Revenue Code 121. How long must my wife and I own our primary home to avoid tax on our capital gain up to $500,000? We purchased our home in July 2003. Can we sell it now and avoid tax on the gain up to $500,000? - Richard W.A: To qualify for up to $500,000 tax-free principal residence sale capital gains, you and your wife must own and occupy your home at least 24 of the 60 months before its sale and file a joint tax return in the year of sale.
However, if you acquired the residence in an Internal Revenue Code 1031 tax-deferred exchange, you must own it at least 60 months to qualify with the same 24-month occupancy requirement. For full details, please consult your tax adviser.

<b>Q:</b> Last year, my wife and I loaned our daughter and son-in-law the money they needed to buy their first home. We weren't earning much on the money and they offered to pay us 5 percent interest. It was a good deal for them and a good deal for us. They faithfully pay us the monthly interest and principal. However, when they had their income taxes prepared, their tax adviser told them that the approximately $32,000 of interest they paid us in 2005 is not tax-deductible because it is an unsecured loan, which is not recorded against their title. Please tell us this isn't true. - Gregg G.<BR>
<b>A:</b> Their tax adviser is correct. For your daughter and son-in-law to deduct the interest payments paid to you as itemized home mortgage interest, the loan obligation must be secured by a recorded mortgage or deed of trust against their home.<BR>
Although you and your wife must report on your tax returns the interest income received, the borrowers are not entitled to deduct it as home mortgage interest because the loan isn't secured by their residence. However, this can be corrected for 2006 by their signing and recording a mortgage or deed of trust to secure the promissory note they gave to you.<BR>
<b>Q:</b> About a year ago, my husband and I refinanced our $375,000 home mortgage with a 5.5 percent interest rate loan. Now we are in a financial position to pay off our mortgage in full. But our CPA son-in-law advises against doing so. He says we need every tax deduction we can get. However, I would like to be free of the monthly mortgage payments. What do you advise? - Amy T.<BR>
<b>A: </b>Listen to your smart son-in-law. Unless you are in a very low income tax bracket, your after-tax mortgage interest rate is only about 3.5 percent. That's a true bargain.<BR>
Surely you can find a safe place to invest that $375,000 to earn more than 3.5 percent interest. Then you will have that money available for an emergency or investment opportunity.<BR>
Another consideration is to check if your mortgage has a prepayment penalty. If it does, that settles the matter in favor of not paying off your mortgage.<BR>
<b>Q:</b> About five years ago, my aunt died. She left everything to me, including a worthless lot. I consulted several nearby Realtors and they wouldn't even list it for sale as it is only worth around $5,000. However, the county keeps sending me the property tax bills, which I haven't paid. They have tried to sell the property at a tax sale but nobody will buy it even for the amount of unpaid property taxes. Now the county reported to the credit bureaus that I owe the unpaid taxes and this is hurting my credit rating. What can I do? - Ralph R.<BR>
<b>A: </b>It is very unfair for counties to report unpaid property taxes to the credit bureaus, especially when you inherited worthless property you don't want.<BR>
Perhaps you can contact the county tax collector to see if he will accept your quitclaim deed in return for canceling the property taxes. Then you can tell the credit bureaus the property taxes have been canceled so the adverse information can be removed from your credit reports.<BR>
<b>Q:</b> In 1993, my wife's father died. He left everything to her in his will. There are no siblings or other close relatives. Knowing she inherited the house, we moved our family in and have been living in the house and paying its mortgage ever since. Now that our kids are grown and on their own, we want to sell the house and "downsize" for our retirement years ahead. However, when we talked with a Realtor about listing the house for sale, she said we can't sell it until my father-in-law's estate is probated and the house title is transferred to my wife. Is there any way to avoid probate? - Jerome W.<BR>
<b>A:</b> No. However, many states have speedy small estate probate procedures for situations like the one you describe. Because your late father-in-law willed his house, probate court proceedings are usually required.<BR>
Probate could have been completely avoided if he held title in his revocable living trust, specifying that after his death the house should go to your wife. However, it's now too late for that.<BR>
I suggest that your wife consult a local experienced probate attorney to probate the will. He or she can often expedite uncontested probate matters in less than the six to 12 months usually required.<BR>
But your wife has another problem to consider. When she receives the title, she will receive a new stepped-up basis to market value in 1993. Since then, the house has probably greatly appreciated in market value.<BR>
However, you and she can't qualify for the Internal Revenue Code 121 principal residence sale tax exemption up to $500,000 because she hasn't owned the house at least 24 months (although you both clearly meet the 24-month occupancy test). Consultation with your tax adviser is strongly suggested.<BR>
Send questions to Robert Bruss, 251 Park Road, Burlingame, CA 94010 or through his Web site, www.BobBruss.com<BR>
<b> Q: </b>I live in a condo complex where one owner has four barking dogs. The neighbor has never walked the dogs and keeps them in a tiny fenced patio. The smell is unbearable in hot weather. The condo homeowner's association refuses to act even though the CC&Rs (covenants, conditions and restrictions) only allow one small pet. What can be done? - Dorothy J.<BR>
<b>A:</b> Shame on your ineffective homeowner association board of directors and officers for refusing to enforce the CC&Rs. However, your city or county health department, or the local humane society, can take action to abate this nuisance, which is also a health problem. A few phone calls should solve the problem.<BR>
<b>Q:</b> My friend and I have a disagreement about Internal Revenue Code 121. How long must my wife and I own our primary home to avoid tax on our capital gain up to $500,000? We purchased our home in July 2003. Can we sell it now and avoid tax on the gain up to $500,000? - Richard W.<BR>
<b>A:</b> To qualify for up to $500,000 tax-free principal residence sale capital gains, you and your wife must own and occupy your home at least 24 of the 60 months before its sale and file a joint tax return in the year of sale.<BR>
However, if you acquired the residence in an Internal Revenue Code 1031 tax-deferred exchange, you must own it at least 60 months to qualify with the same 24-month occupancy requirement. For full details, please consult your tax adviser.<BR>